Thames River Capital

The multi-manager team, doing it differently

SIMON KERR

Thames River Capital came into being in the late 1990s not long after Marshall Wace and around the same time as RAB Capital. Each group has followed a different path to growth according to the biases and backgrounds of the principals of the firms. In the case of Thames River Capital (TRC/Thames River) the route has been by diversification by asset class and fund format.

So today, of the $11bn assets under management (as at 31.05.07) 42% are managed in the hedge fund format, and multi-manager is expected to be a major part of future growth both in long-only under Gary Potter and Rob Burdett, and multi-manager hedge funds under Ken Kinsey-Quick. The multi-manager hedge fund business was created near the inception of Thames River, but was in danger of withering way until Kinsey-Quick arrived in January 2003 with the mandate to turn it around. He has achieved this by deliberately creating a throwback at Thames River. The Hedge Fund Journal went to find out how and why this was done.

The lesson of Haussmann Holdings was innovationAccording to the Head of Multi-Manager at Thames River, Kinsey-Quick, the fund of hedge funds industry is still largely as it was five years ago in its risk appetite. “The returns have been bland because not enough risk has been taken, as the fiduciary responsibility has been paramount due to the institutionalisation of the industry,” he states with certainty. He says that the low risk appetite elsewhere has been good for Thames River’s fund of funds effort in that the majority of the competition has been operating with a constrained concept of what they have been there to do. This has enabled Kinsey-Quick to differentiate his team’s approach for potential investors in the funds of funds. The differentiation is expressed rather graphically in the pitch-book which contains a photo-montage of a fork in a road through a desert. The broad tarmaced road in one direction is the ‘Institutional Way (offering single digit returns)’ and the other direction is via a dusty narrower path labelled ‘The Innovative Route (double digit returns)’.

The broad highway has become a bond alternative, whereas in the 1990’s hedge funds were an equity alternative. So Kinsey-Quick tells potential institutional clients that if they are buying hedge funds as an equity alternative with lower volatility, harking back to the previous decade, then they are going to be disappointed. But if they are looking for diversification in an efficient portfolio then that is a different matter.

“The crux of what we are trying to do here at Thames River,” says Kinsey-Quick, “is to take fund of funds back to where the grandfather of the hedge fund industry, Hausmann Holdings, (where he cut his teeth) was. What made Haussmann deliver double-digit annual returns with single-digit volatility over 30 years was the fact that it was innovative. It was the first to invest in equity long/short when it started and was the first to invest in CTAs in the 1980’s when that strategy began.” He continues, warming to his theme, “In the early 1990s Haussmann Holdings was early into global macro when that strategy came along. Generally these days, funds of funds are so well diversified, with many managers operating in different ways, that you can afford to take the risks of innovation. Somehow this idea has become lost over the years as the industry has become more popular and more institutionalised,” he adds somewhat bemused.

“When I started in this industry in 1994 there were only three hedge fund strategies. Today there are eleven recognised hedge fund strategies, and there are more on the cusp of being recognised. For each of them there were double-digit returns at first, and then, as more capital is applied in the strategy, returns drift down to single-digit levels. When I joined Thames River in 2003 I said to Charlie Porter (Thames River’s Chief Executive) that it was pointless setting up another institutional fund of funds. We didn’t have the track record to compete with the GAMs, the Ivy’s and FRM’s with their systems and massed ranks of analysts. By contrast I inherited just two analysts and $80m AUM. What has happened is that fund selection has become dominated by the ticking of boxes and risk control. I can understand where the institutions are coming from, and that the fiduciary responsibility is being taken very seriously by the middle-men (funds of funds), just as we take it seriously. For my part, I see a lot of investments that are fabulous from a personal point of view: I see they are going to make a lot of money. But it is different looking at them from a fiduciary point of view.”

According to Kinsey-Quick the industry in the Noughties has maintained the Sharpe ratio of returns seen in the Nineties, but through lower absolute returns and lower volatility of those returns. He says that this is partly explained by the improvements in risk management he has seen broadly across the single-manager part of the industry as the industry responds to itsnewest, biggest clients: institutions.

A seasoned investment staff is keyA feature of the multi-manager effort at Thames River is that the team itself and the way it operates are quite unlike the typical fund of funds firms that serve the institutional market. There are eight investment professionals on the team. Besides Kinsey-Quick, the two that share fund management responsibilities are Alex Kuiper and recent recruit Bill Muysken (see biographies). Like Kinsey-Quick, Kuiper is a partner in the multi-manager business of Thames River. “We are very complementary,” explains Kinsey-Quick: “As Bill pointed out when he started, I see the glass half-full and Alex sees it half empty.”

He continues: “the management structure within our group is flat and not a pyramid structure. Also we don’t have silos of responsibility by strategy (as you see elsewhere). We are more horizontally structured in that each member of the team has a different area of expertise in assessing a fund, and we all evaluate every fund we consider for investment. When looking to add to the team I have looked for experience first. The average age is over 40. It is key to how we operate. I try to find people that are better than me in their respective areas, and I leave them to get on with it. I don’t look over their shoulders the whole time.

“For example, Stan Chaudhry was a due diligence manager at Deloitte & Touche so he came here knowing a lot about how to assess the operational risks of hedge funds, and that is what he looks at for us. He is fantastic at what he does. We are very much investors in early stage managers, and there are particular risks associated with them, and Stan keeps us in the operationally stronger managers.”Haussmann Holdings

Haussmann Holdings is one of the world’s oldest, largest and most renowned multi-manager funds. Itwas established in 1969 by the French-based Worms & Cie and the Swiss-based Notz, Stucki & Cie SA as a US-focused fund of hedge funds that has been effectively managed by a group that includes the Permal Group, Notz Stucki, Mirabaud and Cie, and Banca del Ceresio.

Haussmann Holdings has always been run with a concentrated portfolio: in 1998 the C5 and C10 percentages were 45 and 73%, and as recently as 2003 the top 10 holdings still accounted for 65% of the fund with Caxton managing over 20% of the capital. It has since become more international in its remit, but still has had capital with the likes of Louis Bacon, Mark Kingdon and Tudor’s James Pallotta for over a decade.

Tomorrow’s mainstream strategiesSo if funds of funds have to grasp the opportunities presented by investment strategies at the frontier of the available universe, where have Thames River’s multi-manager team placed their bets? Among niche areas that they see may offer opportunities for profitable exploitation in the years ahead are electricity trading, direct lending and structured credit. Carbon trading is another sector that Kinsey-Quick thinks has the potential to become a big area of interest over the next 5 -10 years. He explains, “We are known to seed hedge funds, so we see a lot of people about to enter the business. It means that we are always seeing new investment strategies, and we have an idea of what is at the edge. Take the carbon markets: we saw a manager last year, which gave us a chance to discuss the strategies available in some depth. We still had some questions about the way they operated, so we monitored them for three months, and then said no. However, we took that knowledge and that enabled us to work closely with another carbon trader that we eventually seeded with a fee break arrangement.”

On occasions a more structured approach to a new strategy is taken. If Kinsey-Quick comes across a new strategy he likes he works with his colleague James Rous to narrow the search amongst managers. “James sees the counterparties in the particular strategy to get input on who are the better managers,” says Kinsey-Quick. “Then he goes out and sees the managers to create a shortlist of five or so – in Oslo, or Buenos Aires or wherever. We think of James as our opportunity analyst.”

It is typical for allocations to new strategies to start small, just as allocations to new managers in familiar strategies start small in the portfolios. A holding may be 50 or 75 basis points of the whole fund whilst the Thames River team increase their comfort with both the manager and the strategy. “We like to start small and pyramid in across all the funds,” advises the experienced Kinsey-Quick. “For new strategies you need ‘skin in the game’ – that keeps you focused on the area. We have used this approach recently in looking at funds involved with shipping derivatives, and our knowledge is building up there across a number of funds.”

No OptimiserAnother way in which Thames River’s multi-manager team is distinguished from the funds of hedge funds that serve large institutional investors is in the inputs to decision-making. All the large funds of funds that are taking share at the top end of the business have extensive quantitative capability and typically have a dedicated risk management/measurement function. For some years they have competed on the basis of the rigour of their processes and smarts of their quants.

By contrast the smarts at Thames River are in the heads of the staff, not coded in C++. “We are qualitative in assessing managers. Nic Karageorgis joined us a couple of years ago to help assess investment risk using quantitative methods, so it is not that we don’t have them. But we don’t use an optimiser to build portfolios,” states Kinsey-Quick. “We want to look forward without looking in the rear view mirror, because what we do is select managers or strategies or asset classes that will do well looking ahead. I believe a fund of funds manager has to take some top-down view in building a multi-manager hedge fund. In doing that we often have a contrarian bias. We are drawn to look at an asset class or strategy that has done badly to see if that could change. We like to look for established managers that have not done well recently. You know, hubris settles in no matter how good the managers are. They have negative returns, and the capital runs out from their funds. That is when we like to re-visit a strategy or manager, say like convertible bond arbitrage a couple of years ago.”

To make money you have to take a directional view He continues, “We believe that if you want to make money in investing through hedge funds you have to take some directional risk. For us that means that the returns have a beta to some asset class, and it may be either long or short. I can give you some examples. On the long side, we are very bullish on the healthcare sector in equities. It has not done well as a sector since the late 1990’s and there are very good macro reasons which make us think it will do well in the medium term. Even though we are bearish on equities overall at this point, we still expect healthcare to do well. So we have exposure in our funds to a long-biased healthcare manager.

“On the short tack, last year we took a view on sub-prime mortgages. As it happens we thought from a macro standpoint that if the markets were going to become less benign it would start with the US consumer. “In fairness we put this in as something of a hedge (on the whole fund of funds portfolio), but it worked out very well.” This is an understatement. The fund chosen by Kinsey-Quick was up 66.92% in February alone. The contribution to return of this one decision should be enough to make the differential return for the whole of 2007 that will distinguish the Thames River multi-manager funds in the performance rankings.

The existing rangeWhen Kinsey-Quick arrived at Thames River there were just two funds of hedge funds: a lower volatility target product called Sentinel, and Warrior which is permitted more variance in return. The new Head of Multi-Manager quickly enacted one of the themes in funds of funds at the time. He introduced more specialised products.

The Distressed Focus Fund was launched in July of 2003, and the Equity Focus Fund was launched a few months prior to that. These two funds have a range of currency classes, and as is usual they tell a story of where those products are sold. Both the funds have a £-Class, partly reflecting sales to UK clients, and both have Swedish Krona Class shares reflecting the Thames River distribution capability in what is arguably Europe’s most developed end-market for hedge fund product.

The Thames River Sentinel Fund seeks to achieve consistent, low volatility absolute returns in excess of risk-free rates by investing in a well-diversified portfolio of non-directional hedge funds. Non-directional strategies dominate. A couple of hedge fund strategies, equity market-neutral and fixed income arbitrage, only have allocations in Thames River’s funds within Sentinel.

The Flagship Fund – WarriorThe Warrior Fund aims to achieve 10%+ pa. returns over a cycle by investing opportunistically in a portfolio of both directional and non-directional hedge managers. Warrior is made up of four sub-portfolios, each with different risk/return characteristics:

The Core Portfolio (currently 54% of the whole)is a more bottom-up component, and has high conviction allocations by manager and strategy. Allocations to a single manager range from 5 to 15%, and they tend to go to the high conviction portfolios of established managers such as AlphaGen Tucana run within Roger Guy’s team at Gartmore and CQS’s Directional Opportunities Fund. Five manager holdings have been 50% of the whole fund before now. There is also a top-down strategy allocation such that at times 90% of the whole fund has been in just three strategies.

The Seed Portfolio (currently 3%) is a hybrid between private equity and hedge fund investing.

The Special Situations Portfolio (39%) has two components. One strand is ‘the hedge fund strategies of tomorrow’ – the likes of electricity trading and carbon credits – where it is hoped to capture a first mover premium. Structured credit was first introduced in this strand 3 or 4 years ago. The second strand is the directional view taking described previously. These have a 20% pa. target return and a time-frame of a 12-24 month payoff.

The Leveraged Portfolio (4% currently) is a call option on a diversified multi-strategy portfolio of hedge funds managed pari passu to the Sentinel Fund, giving gearing of about 3x. The manager treats this as ‘a spinnaker’ in running a multi-manager fund, and given the current rate risk environment the spinnaker is not fully extended according to him. “The important thing is to keep a flexible mandate,” says Kinsey-Quick. “As a multi-strategy selector you have to be able to be opportunistic.”

New Funds – Warrior II and Currency FundsAccording to Kinsey-Quick for multi-strategy hedge funds today, a sensible approach requires the discipline to exit strategies where excess returns are being competed away and capping or closing funds to new money at sensible levels. So the Warrior Fund was closed at $500m. “We are capacity constrained,” he confesses, “because we do invest in some niche strategies. We think that if you are much larger than that it becomes difficult to make the double-digit returns we target in Warrior. So we opened Warrior II, though we were concerned that like in the movies the perception may be that the sequel is never as good as the original. That was never our own view. In fact we thought the opposite – that in the first twelve months Warrior II could out-perform the Warrior Fund. This is for a number of reasons. There is always a certain amount of luggage in the holdings in a mature portfolio of hedge funds and in a growing (FoF) vehicle with strong cash inflows you can asset allocate very quickly to make returns in the short term.

“Practically what we did, given that Warrior II was started with $8m, was put the assets in Warrior so that it was well diversified from the start. Then we added individual hedge fund holdings (like core manager M&G Episode) until we could invest directly across the whole of the capital base of Warrior II. We thought that it was feasible to invest directly only when the assets reached $100m, which they did in May.”

An area of opportunity that TRC are set to exploit is currency funds. Bill Muysken has been brought in to be co-portfolio manager of the currency funds with Ken Kinsey-Quick. This appointment is in line with the principal of recruiting senior level staff with experience as Muysken was global head of research at Mercer Investment Consulting and has been following currency funds since the early ‘90s. Thames River launched the Thames River 2X Currency Alpha fund of funds in April, and will follow up with the launch of the Thames River 1X Currency Alpha Fund at the end of June.

Thames River’s new vehicle will invest in 10 to 20 managers employing a broad array of styles, including fundamental and technical analysis, quantitative and discretionary trading, short-term and long-term, with a focus on both developed and emerging markets. The 2X Currency Alpha fund of funds is targeting returns of cash plus 10% annually net of fees, and it charges 1.5% for management and 10% for performance. The funds of funds will use the Deutsche Bank FX Select platform which allows daily dealing, full transparency and exposure to credit risk limited to that of Deutsche Bank itself.

Not operating the dominant model in funds of fundsIn taking the Thames River multi-manager effort back to some of how Haussmann Holdings operated, Ken Kinsey-Quick has gone against the grain of the way of operating of those ever-larger funds of funds that are taking an increasing share of the business.

Thames River does not have massed ranks of analysts with MBAs, nor a Cray XT3 to generate simulations, optimisations and the higher moments of returns of portfolios of hedge funds. Those capabilities are not always required when seasoned professional investor experience can be brought to bear in selecting able managers (the bottom up) and finding when it is timely to allocate to new and mainstream hedge fund strategies (the top down). However the commercial significance of a good three-year track record for institutional investors is as manifest now as it ever was, and the proof is there for Thames River in the way that really counts – the returns.

The approach, resources and infrastructure of the multi-manager hedge fund team at Thames River Capital are not what large institutional investors find easy to buy into. Thames River tick some of the boxes of the investment consultant mediators in the business but not enough of them to compete with Ivy and GAM for mainstream first round allocations.

However, the returns of the flagship fund, and the ability to address emerging hedge fund strategies should push the team into consideration when institutional investors are in phase two of taking hedge fund exposure. Once the end decision-makers at institutions understand where and how risk is appropriately taken in hedge fund investing then the qualities of Ken Kinsey-Quick’s team will stand out. Further, multiple mandates are being awarded. So Avon Pension Fund awarded five mandates to funds of funds recently, and some of the Thames River Capital products would make excellent diversifications from the lower-volatility products of the largest funds of funds around.

With assets under management having doubled to over a billion dollars in the last year, and with a very competitive three-year track record Thames River’s multi-manager team should be giving their marketing department a major headache from completing DDQs for institutional mandates.

Thames River Hedge Ventures: A dedicated hedge fund seeding vehicleIn August 2004 Thames River launched a new fund, Thames River Hedge Ventures Fund (TRHV), which was established to provide backing to promising new hedge fund start-ups. The concept was that TRHV offers investors the potential to benefit from the ‘new manager outperformance phenomenon’ and also to participate in the strong revenues associated with successful and fast growing hedge funds. TRHV was expected to ‘seed’ up to five new hedge funds each year alongside Thames River Capital’s other fund of fund vehicles that allocate a proportion of their assets to start ups. The first investment was seeding a new capital structure arbitrage fund, Lyber Capital Management, with US$25m, but only a handful of seeding commitments have been made since. Ken Kinsey-Quick’s take is that in the current market environment it is easy for managers to raise assets independently of a seeder. Therefore TRC will have to wait until a more difficult investment environment presents itself and managers will struggle to raise assets and will then look to seeders.

Ken Kinsey-Quick, the Portfolio Manager of this Fund, has over 10 years experience of investing in/seeding new hedge funds

Uncorrelated equity-like returns by participating in the profitable, high growth hedge fund industry via investment as well as business returns.

The rationale for investing in and seeding new hedge funds

Fee discounts – The Fund seeks to negotiate substantial fee discounts on its investments in the underlying hedge funds.

Revenue participation – The Fund seeks to negotiate revenue sharing arrangements with the manager of the underlying hedge fund enabling investors to share in the manager’s success.

Exit multiples – Unique to this product, at inception the Fund seeks to negotiate exit multiples requiring the hedge fund manager to buy out the Fund’s revenue participation within a fixed time period.

Achieving all or part of the above benefits can have a significant impact on the performance of the Fund for the same investment risk when compared to investing in the underlying hedge funds on a normal basis.

Ken Kinsey-Quick summed the idea up: “I believe that this is one of the better sources of potentially superior risk-adjusted returns as investors can take advantage of not only hedge fund investment returns but also participate in the business returns of a fast growing industry. There is still plenty of new talent around. You have to kiss a lot more frogs to find the talent in 2007, but there are good managers coming along”.

“An improvement in the industry now is that you see spin-offs from major established groups: the number two PM given capital either within the same firm or by someone else.”

Biographies

Ken Kinsey-Quick joined Thames River Capital in January 2003. He has over a decade of experience in hedge funds with an established track record. He was previously Chief Investment Officer at Coronation International in London. At the end of 1999, he founded Redwood Investment, which was later acquired by Coronation Fund Managers. Prior to that, he spent six years as an Investment Manager at Ifabanque in Paris, co-manager of the well known Haussmann Holdings Fund, one of the first in the industry. He was also involved in the founding and management of the Challenger funds. The flagship Challenger US Fund was ranked No 1 by TASS over the 3 year period prior to his departure from Ifabanque. He also held positions at CCF Foster & Braithwaite and Blue Circle Pension Investments in London. He has a BComm from the University of Cape Town and is a CFA and CAIA charterholder.

Alex Kuiper joined Thames River Capital in September 2001. He was previously at JP Morgan in London where he developed tactical software for the risk management system used by their Exotic Fixed Income Derivatives desk to hedge complex derivative portfolios. Prior to that he held positions in the finance and information technology industries after a short period training as a 2nd Lieutenant in the Royal Marines. He holds a BA (Hons) – Engineering Science (mechanical engineering, specialising in Control Theory) from University College, Oxford and is a CFA charterholder.

Bill Muysken joined Thames River Capital in February 2007. Previously he spent 14 years with Mercer Investment Consulting, where he served as Global Head of Manager Research from 1997 to 2003, and Global Head of Research from 2003 onwards. In 2003 he was named European Investment Consultant of the Year by Global Money Management. During his time at Mercer he gained over a decade of experience in researching currency and global macro managers, and advised clients based in 20 different countries. Prior to that he spent seven years working for the Australian Government in Canberra, where he was a senior policy advisor on pensions, investment and related issues. Prior to that he spent four years with Prudential Assurance in Sydney as an actuarial analyst. He holds a BA in Actuarial Studies from Macquarie University, and is a Fellow of both the Institute of Actuaries and the Institute of Actuaries of Australia.